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Why Dividend Investing Is Here to Stay

Everyone wants what dividends offer.

Never before has there been such strong interest in stocks that pay dividends. Rather than bullheadedly trying to stand in front of the freight train of investor demand for dividend payments, companies are jumping on the bandwagon -- and investors will be the winners.

Bring on the dividendsIn its quarterly look at dividend investing, Standard & Poor's found that dividends are on the rise in a major way. A whopping 117 companies -- nearly a quarter of the S&P 500 -- increased or started paying dividends. That's a 50% increase over the number of companies raising dividends during the first quarter of 2010. All told, dividend payments during the quarter rose by a record $16.6 billion.

Behind those statistics are a number of interesting trends that reflect a paradigm shift in the way that companies manage their excess cash flow. For instance:

During the financial crisis, bailed-out banks chose to slash their dividends in order to conserve valuable capital. Over the ensuing two years, however, their balance sheets have improved to the point at which many banks are making major increases in their payouts, restoring good portions of their pre-crisis dividend payments. JPMorgan Chase(NYSE: JPM) chose to raise its dividend fivefold, making the total increase of roughly $3.1 billion -- almost 20% of the total for the entire S&P 500. Wells Fargo(NYSE: WFC) was also among the many financial companies raising payouts, with an expected total increase of $7 billion among financials making up a huge fraction of S&P 500's overall figures.

In the S&P 500, 10 companies said that they would pay dividends for the first time, including Cisco Systems(Nasdaq: CSCO), WellPoint(NYSE: WLP), and Kohl's(NYSE: KSS). That's the most new dividend payments for a quarter since S&P started collecting data in 2003.

In particular, technology companies, once seen as the haven of non-dividend paying stocks, now have some companies that pay handsome dividends. Intel(Nasdaq: INTC) now has a dividend yield of more than 3.5%, while Microsoft(Nasdaq: MSFT) weighs in at 2.5%.

Of course, not everything is rosy in dividend-land. Even with the big jump in dividends, companies still aren't paying out as much as they did before the financial crisis. In total, quarterly dividend payments remain 13% less than they did at their 2008 peak.

What's next for dividends?With shareholders clamoring for companies to free up cash, the trend clearly seems to favor higher dividends over other ways of returning cash to investors. Stock buybacks remain popular, but with the S&P 500 having doubled in value in just two years, many investors aren't thrilled about companies spending hard-earned cash on shares that no longer provide the value they did at the market lows in 2009.

Ironically, many investors shouldn't be all that happy about getting their money back in dividends. When you receive a dividend payment, you have to decide what to do with the cash. And with yields on cash and fixed-income investments at rock-bottom levels, the only alternative that many feel comfortable with is to reinvest back into shares of stock. All that achieves is a taxable event that creates tax liability for those who invest outside retirement accounts and other tax-favored vehicles.

Nevertheless, the rise of dividend stocks likely stems from another phenomenon: accountability. As much as investors may want companies to find lucrative ways to deploy the profits they generate, they don't want corporate leaders to mismanage their cash and blow it on ill-advised maneuvers like expensive acquisitions. By putting cash back in their hands, investors feel more confident that their companies are doing the right thing -- and putting their money to best use.

Watch for dividendsIf the economy finally starts growing at a faster pace, then investors may give up on relatively defensive dividend stocks in favor of faster-growth alternatives that provide better prospects for capital appreciation. But until that happens, investors will be happy to collect dividends while they wait for better times ahead.

If you want to get on the dividend investing bandwagon, make sure you start on the right foot. Our free special report, "13 High-Yielding Stocks to Buy Today," has plenty of good places to start.

Fool contributorDan Caplingerwants dividends that will hang around for a while. He doesn't own shares of the companies mentioned in this article. Intel, Microsoft, and WellPoint are Motley Fool Inside Valuechoices.Motley Fool Optionshas recommended diagonal call positions on Intel and Microsoft. The Fool has created a bull call spread position on Cisco Systems, bought calls on Intel, and owns shares of Intel, JPMorgan Chase, Microsoft, and Wells Fargo. Motley Fool Alpha LLC owns shares of Cisco Systems and Microsoft. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool'sdisclosure policyis definitely here to stay.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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